1. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-1 Chapter Three Working with Financial Statements

2. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-2 3.1 Cash Flow and Financial Statements: A Closer Look 3.2 Financial Statements of Publicly Listed Firms 3.3 The Du Pont Identity 3.4 Using Financial Statement Information 3.5 Summary and Conclusions Chapter Organisation

3. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-3 Chapter Objectives Identify the ways that firms obtain and use cash as reported in the Statement of Cash Flows. Calculate and interpret key financial ratios. Discuss the Du Pont identity as a method of financial analysis. Understand the use of financial information for comparative purposes. Outline the problems associated with using financial ratios.

4. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-4 Cash Cash is generated by selling a product or service, asset or security. Cash is spent by paying for materials and labour to produce a product or service and by purchasing assets. Recall: Cash flow from assets = Cash flow to debtholders + Cash flow to shareholders

5. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-5 Cash Flow Sources of cash are those activities that bring in cash. Uses of cash are those activities that involve spending cash. The firm’s statement of cash flows is the firm’s financial statement that summarises its sources and uses of cash over a specified period.

6. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-6 Statement of Financial Position ('000s) Assets (‘000s)20032004 Current assets Cash Accounts receivable Inventory Total Fixed assets Net plant and equipment TOTAL ASSETS $ 45 260 320 $ 625 985 $1 610 $ 50 310 385 $ 745 1 100 $1 845

7. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-7 Statement of Financial Position ('000s) Liabilities and equity (‘000s)20032004 Current liabilities Accounts payable Notes payable Total Long-term debt Shareholders’ equity Ordinary shares Retained earnings Total TOTAL LIABILITIES AND EQUITY $ 210 110 $ 320 $ 205 290 795 $1 085 $1 610 $ 260 175 $ 435 $ 225 290 895 $1 185 $1 845

8. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-8 Statement of Financial Performance ('000s) Net sales$710.00 Cost of goods sold 480.00 Depreciation 30.00 EBIT$200.00 Interest 20.00 Taxable income 180.00 Tax 53.45 Net profit$126.55 Dividends 26.55 Addition to retained earnings $100.00

9. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-9 Statement of Cash Flows A statement that summarises the sources and uses of cash. Changes are divided into three main categories: – Operating activities—includes net profit and changes in most current accounts – Investment activities—includes changes in fixed assets – Financing activities—includes changes in notes payable, long-term debt and equity accounts as well as dividends.

10. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-10 Statement of Cash Flows Operating activities + Net profit + Depreciation + Any decrease in current assets (except cash) + Increase in accounts payable – Any increase in current assets (except cash) – Decrease in accounts payable Investment activities + Ending fixed assets – Beginning fixed assets + Depreciation

11. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-11 Statement of Cash Flows Financing activities – Decrease in notes payable + Increase in notes payable – Decrease in long-term debt + Increase in long-term debt + Increase in ordinary shares – Dividends paid

12. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-12 Statement of Cash Flows Operating activities + Net profit+ $ 126.55 + Depreciation+ 30.00 + Increase in payables+ 50.00 – Increase in receivables– 50.00 – Increase in inventory– 65.00 $ 91.55 Investment activities + Ending fixed assets+$1 100.00 – Beginning fixed assets– 985.00 + Depreciation+ 30.00 ( $ 145.00)

13. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-13 Statement of Cash Flows Financing activities – + Increase in notes payable+ $ 65.00 – + Increase in long-term debt+ 20.00 – – Dividends– 26.55 $ 58.45 Putting it all together, the net addition to cash for the period is: $91.55 – 145.00 + 58.45 = $5.00

14. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-14 ‘Players’ in Accounting Standards Accountants Government Regulators Other users

15. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-15 Ratio Analysis Financial ratios are relationships determined from a firm’s financial information. Used to compare and investigate relationships between different pieces of financial information, either over time or between companies. Ratios eliminate the size problem.

16. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-16 Categories of Financial Ratios Liquidity—measures the firm’s short-term solvency. Capital structure—measures the firm’s ability to meet long-run obligations (financial leverage). Asset management (turnover)—measures the efficiency of asset usage to generate sales. Profitability—measures the firm’s ability to control expenses. Market value—per-share ratios.

17. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-17 Liquidity Ratios

18. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-18 Capital Structure Ratios

19. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-19 Turnover Ratios

20. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-20 Turnover Ratios (continued)

21. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-21 Profitability Ratios

22. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-22 Market Value Ratios

23. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-23 The Du Pont Identity Breaks ROE into three parts: – operating efficiency – asset use efficiency – financial leverage

24. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-24 Uses for Financial Statement Information Internal uses: – performance evaluation – planning for the future External uses: – evaluation by outside parties – evaluation of main competitors – identifying potential takeover targets

25. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-25 Benchmarks for Comparison Ratios are most useful when compared to a benchmark. Time-trend analysis—examine how a particular ratio(s) has performed historically. Peer group analysis—using similar firms (competitors) for comparison of results. Global Industry Classification Standard (GICS) used by ASX is a useful way to find a peer company.

26. Copyright  2004 McGraw-Hill Australia Pty Ltd PPTs t/a Fundamentals of Corporate Finance 3e Ross, Thompson, Christensen, Westerfield and Jordan Slides prepared by Sue Wright 3-26 Problems with Ratio Analysis No underlying theory to identify correct ratios to use or appropriate benchmarks. Benchmarking is difficult for diversified firms. Firms may use different accounting procedures. Firms may have different recording periods. One-off events can severely affect financial performance.